New jail threat for Hong Kong bankers

Commentary: Are they scapegoats for mainland China equity fraud?

HONG KONG (MarketWatch) — It is doubtful many would shed tears if a few unpopular bankers were to end up in jail. This fate now looms as a new career risk for Hong Kong bankers if proposals to make listing sponsors legally liable for the accuracy of prospectuses goes through.

Last week, the Hong Kong’s Securities and Futures Commission (SFC) said it plans to consult the market over tougher new regulations for listing sponsors. (See report on SFC’s plans.)

But are the real culprits being targeted, or only those within easy reach?

There is little dispute that better policing of Hong Kong’s stock market is necessary following a spate of financial scandals coming to light shortly after new companies listed recently.

But who exactly is to blame for these fraudulent companies making it to the main board of the stock exchange — the auditors who have signed off the accounts, the directors who run the listed companies, the bankers who bring the deal to market, or the investor public demanding a slice of the latest hot investment craze?

Or perhaps, is it ultimately the regulator who vets new listings?

One explanation for the SFC crackdown on bankers is because it cannot target the companies themselves. This can be explained by Hong Kong’s regulatory regime.

Unlike many markets where there is a single regulator, Hong Kong has dual regulation, in which the SFC regulates financial intermediaries like banks and brokers, while listed companies are primarily the responsibility of the Hong Kong Stock Exchange.

A recurring criticism of Hong Kong Exchange & Clearing (HKEx) (388)
HKXCF, -0.33%
is that it’s conflicted by being both a profit-maximizing listed exchange and a regulator of companies that list on it.

In order to get more companies through the door and generate fees, the suspicion is that HKEx will go easy on listing hurdles, due diligence and tracking down offenders.

This criticism was raised as far back as 2003 after an expert group commissioned by the government recommended HKEx’s regulatory role be given to the SFC. This all came to nothing, however, after protests from business interests. Although today the SFC gets to review HKEx’s regulatory report, it is very much a back-seat driver.

HKEx is certainly hitting a rich seam under the current regime. The Hong Kong market was the world’s largest for initial public offerings in 2009 and 2010, when $89 billion was raised there, according to PricewaterhouseCoopers.

The suspicion, though, is that quality is being sacrificed for quantity.

Recently, respected Fidelity fund manager Anthony Bolton described Hong Kong as “a sausage factory,” with companies coming to the market all the time.

This is not to say that bankers skimping on underwriting diligence as they pursue listing fees are not part of the problem.

Over the weekend, the SFC announced its harshest punishment to date of a listing sponsor, stripping Taiwan’s Mega Securities of its licence to advise on corporate finance deals and fining it a record 42 million Hong Kong dollars ($5.4 million) due to shoddy due diligence.

Evidence also suggests this is a wider problem, rather than a few bad apples. The SFC has warned at least eight times since early 2011 about inadequate due diligence by investment bankers who underwrote the IPOs of companies that applied for listings in 2010

Further, mainland Chinese listings appear to be a particular problem. More than a quarter of mainland firms that went public on Hong Kong’s main board since 2010 have cut forecasts subsequent to listing. Granted, the mainland economy is slowing, but this is a large number.

Bringing suspect-quality issues to market damages Wall Street reputations, but perhaps this is not a big enough stick — particularly if your name is Mega Securities. The threat of jail time is likely to make bankers rein in overly bullish forecasts.

Still, where do you draw the line between some rose-tinted forecasts creeping into a prospectus and everyone being duped by companies’ intent on fraud?

Investment bankers will want to make sure they don’t become a convenient whipping boy for some of the audacious mainland Chinese fraud that has appeared recently.

Take for example the case of Longtop Financial Technologies, a Chinese financial-software company where a mainland bank was in on the scam, stating the company had millions of cash deposits that did not exist. While this was a U.S. listing, Hong Kong has seen similar tales of woe.

Meanwhile, there is still no easy answer dealing with fraud uncovered at mainland Chinese companies listed overseas, due to the difficulty of seeking legal redress in a foreign jurisdiction.

Overall, it would be understandable if Hong Kong were a little complacent, as it is generally thought to have a better reputation for mainland listings than other international markets. But this was often because it tended to attract the cream of those companies listing outside of the mainland Chinese markets.

But now, with the majority of the better-quality and larger mainland companies having listed, HKEx finds itself having to cast its net wider to find IPO business from all corners of the globe.

This suggests maintaining listing standards and corporate governance could get even more challenging. Perhaps it is time for wider reform and not just cracking down on bogeyman bankers.

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